Option Bid Above Intrinsic Value

euroazn

I fail to see the issue - if the option isn't expiring any time soon, it will still have time value, even if it is in-the-money.

You're considering just European style options, right? With American-style, you can exercise at any time.

Not all in-the-money options have time value. In fact, the way it's taught in options theory is that in-the-money options do not have time value at all, they are only composed of intrinsic value (refer to Natenberg: Options Pricing and Volatility). However, in reality, options that are in-the-money but not deep in the money can still have time value. (At least this is the case with crude/natgas futures/options, the area I'm involved in). The super high delta options (deep in-the-money) are only composed of intrinsic value, no time value.

Giving this a whirl but here it goes...

You could buy the underlying and sell the call (let's assume it's a call) and make a small profit. But there's interest rates and transaction costs. Let's assume you're talking about the following scenario:

$100 Call Underlying is trading @ 134.40 the 100 call is 35/39 (35 bid, 39 offered)

You buy the underlying @ 134.40, and you sell the 100 call for $35. If you get assigned on the call, you've already bought the underlying at 134.40, so you still make 60 cents. If the option goes way out of the money, you could lose quite a bit of money on the stock dropping if it goes further down than $35 from where you bought it. All you'll have to cover it is the $35 in premium you collected.

Here's the problem:

Considering this is equities, you'd pay/borrow $134.40 for the underlying, and you'd receive $35 in premium for the option. So you'd be paying interest on $99.40. Say the rate is just 4% - then each night on settlement you lose ~2 cents.(4%/256 trading days = ~.02%).

(Correct me if I'm wrong on the interest rate calculation there - never really looked at interest rates as they're negligible.)

If the option is just about to expire, maybe this would still make sense and the interest cost would be negligible.

Then you have transaction costs - I don't need to go over that for anyone to see how this wouldn't make sense alone just with transaction costs.

All this being said, there are times in equities, supposedly, when there are arbs that can be done in illiquid stocks. I saw a presentation once where a guy was showing where conversions and reversals were still possible on the screen in more illiquid stocks. Conversions/Reversals were something guys in the trading floor pits of the exchanges used to do a lot. Now with electronic trading, that's gone.

Maybe your scenario would work, but it's probably on an illiquid stock. Assuming you could still make money after transaction costs and interest costs, the profit is probably small, and on top of that there's probably not much size on the bid to make it worthwhile.

Please correct me if I'm wrong in any of this, I don't hold myself to be an expert or know-it-all, just putting forth what I can.

Martinghoul

Firstly, like euroazn says, DITM options may, and often do, have time value. There's nothing all that unusual about this. Secondly, it's hard to draw any conclusions w/o actually looking at the specifics of the option. Finally, are you sure you're computing the "intrinsic value" using the correct forward?

The amount of time value deep in the money options have is miniscule, negligible. Once you start getting up into the 98-100 delta options, it's not even worth considering